Citi: “We Have A Problem”

In his latest must read presentation, Citigroup’s Matt King continues to expose and mock the increasing helplessness and cluelessness of central bankers, something this website has done since 2009 knowing full well how it all ends (incidentally not in a deflationary whimper, quite the opposite).

Take Matt King’s September 2015 piece in which he warned that one of the most serious problems facing the world is that we may have hit its debt ceiling beyond which any debt creation is merely pushing on a string leading to slower growth and further deflation. Or his more recent report which explained why despite aggressive easing by the BOJ and ECB, asset prices continue to fall as a result of quantitative tightening by EM reserve managers and China, which are soaking up the same liquidity injected by DM central banks.

Overnight, he put it all together in a simple and elegant way that only Matt King can do in a presentation titled ominously “Don’t look down: You might find too many negatives.”

In it he first proceeds to lay out how things have dramatically changed in recent months compared to prior years: first, the “appalling” asset returns and the “rising dislocations” between asset prices in recent months and especially in 2016, or a broken market which is not just about Crude (with correlation regimes flipping back and forth), or China (as YTD bank returns in Japan and Switzerland are far worse than those in the China-exposed Eurozone), as appetite for risk has effectively disappeared. Worse, as the Japanese NIRP showed, incremental easing in the form of QE actually triggered ongoing weakness, sending both the Nikkei and the USDJPY plunging, suggesting that central bank grip on markets is almost gone.

King then notes that while spreads are at recessionary levels, yields – courtesy of record low interest rates – are still quite affordable and “in principle there is nothing to worry about”, perhaps it is just the market overshooting: he points out several lagging indicators such as employment and loan demand which do not suggest that a recession is imminent and all that needs to happen is to “replace fear with greed.”

That is easier said than done, though, because despite all the “adjustments” data is already rapidly deteriorating, not only in manufacturing where the entire world is in a recession, but also in services as today’s contractionary Markit report showed.

King then begins his conclusive tour de force by noting that “None of the his is supposed to be happening” – inflation and economic growth are supposed to be rising in a world as manipulated by central bankers as this one. Instead, the opposite is taking place.

So where does that leave us? Having laid out the issues ailing the market, he note that “maybe it all fizzles out by itself”…

Actually, it’s not just one problem. Many problems.

Problem #1: the world finds itself in the aftermath of a series of bubbles inflated by central banks, compounded by the market’s own realization that “we are now running out of greater fools.”

Problem #2: “Whenever we’ve had these spread levels… we’ve always been rescued by central banks.” This time, however, they are either late, or their interventions are failing.

Problem #3: The marginal effect of easing is no longer positive, and “everything QE was supposed to have done, it hasn’t”

Problem #4: as a result of coordinated, global intervention, central banks are now forced to fight not just local but global demand shortfalls.

Problem #5: As a result of this global coordination, countries that withdraw liquidity such as EM and China, offset the “favorable” impact of central banks which contribute to liquidity.

Problem #6: as global central banks now operate as a cabal, this has “serious implications”, namely 1) individual CBs not in control of their own destinies; 2) Everything ECB and BoJ are doing is being offset by outflows from EM, and 3) What do these correlations imply for
herding?

Problem #7: As a result of this required, but failed coordination, the world is left with a global problem that desperately needs a solution. “What should be done”, King asks, and provides the following menu of policy actions, however as he adds, “the things which might make a difference feel miles away”… and even further after today Jack Lew warned not to expect anything out of this weekend’s G-20 meeting in Shanghai.

And the final Problem: the “next phase” will likely be a crisis of confidence in central banks.

King, at his most ominous, concludes with the only possible response should it come to this: “Sell what hasn’t moved against what has.”

To this we would add one minor tangent: once we get to the “next phase“, sell everything whose value only exists as a result of confidence in central banks.